Jihong Wang and Zejun Lin of Zhong Lun Law Firm analyse the legal challenges created by using private capital to invest in infrastructure development, both in China and by Chinese enterprises looking outbound
The key legislative developments over the past 12 months affecting investment into the project, energy and infrastructure sectors
Legislation relating to the project, energy and infrastructure sectors during the past year was extremely active. The most important change took place in the urban infrastructure investment and financing sector, where, as proposed at the 18th National Congress of the Communist Party of China, the participation of private capital in urban infrastructure investment and operation by means such as concessions was permitted. Subsequently, in May of last year, the National Development and Reform Commission issued the first batch of 80 model projects in infrastructure and other sectors in which private investment in construction and operations is encouraged. This was designed to attract private capital, particularly private investment, to participate in construction and operation in the form of equity joint ventures, wholly owned ventures and concessions. The model projects cover transportation infrastructure, new generation information infrastructure, major clean energy projects, oil and gas pipeline networks and gas storage equipment, modern coal chemical and petrochemical industrial bases. The National Development and Reform Commission is currently accelerating the pace of drafting of the law on infrastructure and utility concessions and it is anticipated that it will be adopted by the Standing Committee of the current National People’s Congress. Additionally, as a major nuclear country accounting for 40 percent of the world’s nuclear reactors currently under construction, the nuclear energy law is currently being drafted, led by the Ministry of Industry and Information Technology. Wang Jihong is priviledged to be participating directly in the drafting process as a member of the drafting committee.
How the trend of private capital participating in infrastructure investment and construction has developed and the main forms that these investments take
Based on our legal practice in this industry, the participation of private and foreign capital in the domestic infrastructure investment and construction sector in the last few years has shown a trend toward diversity. In the past, the favoured sectors were transport (highways and bridges) and environmental protection (sewage treatment and waste disposal), whereas now one can see the hand of private capital and foreign capital to a greater or lesser extent in the majority of infrastructure investment and construction sectors, such as desalination and construction of large sports facilities. Sectors that were traditionally attractive to private capital, such as highways, are seeing a trend of reduced private investment. This is probably due to the fact that after a period of intensive investment, new highway projects with foreseeable high return rates are now rather few in number.
One relatively welcome change is that, in the past, much of the participation of private capital in infrastructure construction and investment was based on capital strength, not technical or management strength. However, in recent years, the number of domestically invested enterprises relying on their technical and management strengths to participate in projects has been increasing. A waste incineration power project for which we provided legal services is a good example. The investor’s waste incineration power generation technology and management greatly reduced its operating costs and accordingly, in terms of its waste disposal fee quote, it had a clear advantage, and on the strength of this advantage, the investor secured the waste treatment projects of more than 10 local governments in BOT (build-operate-transfer) form. For the infrastructure project investors for whom we provided legal services in the past, those that enjoyed particular advantages in terms of technology and management were usually foreign-invested enterprises.
Private capital often participates in infrastructure investment and construction in the forms of BOT, BT (build-and-transfer), TOT (transfer-operate-transfer) and BOO (build-own-operate), and in recent years, some large cities have opted for the PPP (public-private-partnership) model, in which local government and private capital participate together in investment in a project company; a model that is still relatively rarely seen in second and third tier cities. Private capital also indirectly participates in infrastructure investment and construction, an example of which is by participating in investment in certain infrastructure asset securitisation projects.
 The major legal issues involved in the participation of private capital in infrastructure investment and construction in China Firstly, China lacks high-level authorised legislation dedicated to the BOT, BT, TOT, BOO and PPP models. Although certain relevant provisions can be found scattered in the regulations and measures issued by relevant ministerial level authorities and local governments, systematised high-level legislation is lacking. This has led to a situation where operation varies when different local governments opt for BOT, BT or another model, and there is a lack of standardisation. Secondly, when performing BOT or BT contracts, local governments will perform differently. A large infrastructure project will generally require the participation and support of various functional departments of the government to perform the government’s undertakings in the contract. However, as a local government will usually authorise a certain subordinate functional department to execute contracts, it will be that functional department that will interact with the investor, but the coordinating capabilities of the functional department will often be limited. When, in the course of performing contractual obligations, it encounters a situation where it needs to bring together other functional departments to participate in the performance, it will find itself powerless, creating problems in terms of performance capacity and efficiency in handling matters. Lastly, with respect to BT projects, one of the most prominent issues is local governments’ capacity to pay for the repurchase of the project. In practice, the projects of many local governments are linked to the land development returns of a certain area, and if the land development in the area fails to live up to expectations, the local government will have a problem in performing its obligation of paying for repurchase of the project, exposing the investor and financing bank to risks. The major legal issues worth noting when it comes to the project, energy and infrastructure sector in the coming years Safety-related incidents will occur frequently, making the importance of safety compliance particularly obvious. Recently, frequent safety liability incidents in China have occurred not only in Chinese-invested enterprises, but an increasing number have also been occurring in foreign enterprises (for example, the Kunshan dust explosion incident). As the enterprises and responsible persons involved in major safety-related incidents are required to bear not only the attendant civil and administrative liability, but also the attendant criminal liability, this should attract special attention from both Chinese and foreign enterprises. The issue of employment disputes will become more prominent, with the number of cases greatly increasing. China’s labour law emphasises the protection of the lawful rights and interests of workers. With workers’ increasing awareness of using labour laws to protect their rights, Chinese and foreign enterprises have been faced with the frequent occurrence of various employment dispute incidents, with a corresponding increase in relevant legal actions. Subsequently, the enterprise has been the loser in the majority of cases. Accordingly, Chinese and foreign enterprises need to attach great weight to legal issues such as the execution of employment contracts and the dismissal of employees, and duly handle employment controversies so as to effectively guard against labour law risks. The fight against corruption will continue, which means that anti-corruption compliance should be placed on the agenda. The exposure of certain corruption incidents involving foreign enterprises reflects the fact that foreign enterprises that have in the past placed emphasis on the issue of corruption have been letting down their guard in the China market. Accordingly, in the project, energy and infrastructure sectors, which involve massive investment amounts, special attention needs to be paid to guarding against potential commercial bribery risks. |
 The most important legal challenges that Chinese enterprises face in investing in overseas infrastructure In recent years, investment in overseas infrastructure by Chinese enterprises has been increasing. At present, investment by Chinese enterprises in overseas infrastructure is focussed on developing countries in Southeast Asia and Africa. The greatest legal challenges involved in investing in infrastructure projects in these countries and regions are the lack of stability in local laws and regulations and the lack of familiarity of the local governments with international business practice. We were once involved in an overseas BOT case in which, in addition to engaging us and a local law firm as its legal team for its negotiations on the project contract with the local government, the investor, a strong Chinese enterprise, engaged one of the big four accounting firms as its financial advisor. We spent close to two years carrying out long discussions and negotiations on the terms and conditions of the BOT contract with the local government. As the legal framework in the host country to support specifically the BOT model was nearly non-existent, our only option was to search for certain provisions of principle in its basic laws. Additionally, the country was then in the midst of efforts to open up to the outside world, with the work of drafting and revising laws and regulations then all occurring at the same time. This uncertainty in terms of laws made the design of the specific mechanisms and terms of the BOT agreement very difficult, which was particularly manifested in the provision of land, financing and tax breaks. There were certain terms and conditions that went beyond the then current laws and regulations of that country, but were necessary for the project, and needed to be submitted to that country’s legislature for confirmation of their validity. As the negotiation on the project was drawing to a close, the leader of the other party’s negotiating team was replaced, with the new leader proposing major revisions to key terms and conditions on which the parties had reached a consensus after numerous rounds of negotiation. The proposed revisions were unacceptable to the financing bank, as they would have made future financing for the project impossible. In short, the host country government’s unfamiliarity with international commercial practice made the negotiations on the project extremely arduous. Recommendations for Chinese enterprises wishing to invest in overseas infrastructure construction projects, particularly for those wishing to open markets and develop and engage in business in developed countries Firstly, they should place emphasis on the risks attached to the offshore infrastructure project, carrying out due diligence investigation, carrying out a comprehensive survey and extensive analysis of the economics and politics of the host country where the project is to be located and duly assess the various risks attached to the project, including assessing the host country government’s credit rating and performance capacity. Secondly, at the stage of negotiation for execution of the contract, the company needs to use its best efforts to secure the warranties and incentives that the host country government can offer under the host country’s current legal framework. They also need terms and conditions that go beyond that country’s current legislation, and should request that the government submit the same to the legislature for confirmation. Thirdly, in the course of construction of the project, the company needs to maintain timely and good communication with the relevant authorities of the host country government, so as to secure the timely cooperation of the host country government in practice. Finally, as an infrastructure project will usually have a certain impact on the environment and natural resources in the place where the project is located, the investor must actively communicate and cooperate with the local population and organisations, duly handle its relationship with the local society, actively bear social responsibility in terms of safety, environmental protection and social returns and establish a philosophy of sustainable development. Only in this way will it be able to secure the support of the local society for the project. With respect to a Chinese enterprise wishing to open markets and develop and engage in business in a developed country, we are of the opinion that, in addition to due diligence as mentioned above, it should pay attention to the following two points. The first point is that it may have to change its investment philosophy and learning how to act in accordance with international practice. Generally speaking, Chinese enterprises still lack experience in investing overseas, and particularly in mature markets and countries. When they engage in business, they usually place great weight on relationships. As there exists a relatively good discrepancy between their practice of establishing cooperative relationships with which they are familiar and the internationally commonly accepted commercial philosophy of honouring rules, honouring laws and honouring contracts, for a Chinese enterprise to be recognised and accepted by business entities in a mature market, it first needs to change its trading philosophy, learn to comply with the local laws, regulations, beliefs and conventions of the host country, as well as place emphasis on environmental protection and carry out its investments in accordance with international practice. Also, learning how to identify and select professional intermediary firms and planing out the division of responsibilities between Chinese and foreign professional firms will help. Chinese enterprises need to learn to employ a professional to do a professional’s job. When a Chinese enterprise wishes to invest in a developed market, it needs to rely on a Chinese law firm to manage and coordinate with a local law firm. On one hand, the long-term relationship of confidence between a Chinese law firm and enterprise, and the communication advantages in terms of language and culture are things that a local foreign firm cannot replace. On the other hand, Chinese enterprises need to rely on the Chinese firm’s professional legal capabilities and its contacts with legal circles in the developed market to assist it in selecting the most reasonable foreign law firm in terms of price-performance ratio, with the Chinese and foreign law firms jointly forming its legal team, following up throughout the entire process, liaising and exchanging ideas and controlling risks. |
wangjihong@zhonglun.com
linzejun@zhonglun.com
www.zhonglun.com